Correspondent banking – being a broad array of services through which one bank sub-contracts or sources from another – generally functions well for users. However the payments component of it, although strong for high value transactions, is less suitable for low-value international payments.
The correspondent banking model was, after all, put in place at a time when there were relatively few such transactions. Since then, the mass migration of labour, economically active migrants, the advent of the internet and the widespread adoption of mobile phones have collectively led to a growth in demand for more retail-oriented functionality than is currently possible through correspondent banking.
Payments are a multi-sided business problem; there is a ‘first mover’ disadvantage – the first investor depends on adoption by many others before a return can be made. A solution to this challenge is to assemble existing components of the banking system in a different way, to achieve a better outcome.
The International Payments Framework Association (IPFA) is one example; it has established standards, based on industry-standard ISO 20022, which enables national automated clearing houses (ACHs) to interlink directly, so that users in one country can get the benefits of the economies of scale of the domestic clearing in another country.
Arthur Cousins, the IFPA’s chief executive (CEO) agrees that correspondent banking is alive and well but suggests: “We can see that the model is starting to fail to meet the needs of the newer generation of payments makers in the world today. They don’t know the history behind the current model or care about it. They live in a world when everything can, or at least should, be instant. They ask why this isn’t the case with cross-border payments – correspondent banking operates on a two-day basis. It’s no exaggeration to say that many people today send payments internationally and simply hope that they get there.”
Senders and beneficiaries making international payments expect them to have the same characteristics as domestic payments. They need payments to be transparent, predictable and they want to know their progress. Crucially they need the process to incorporate information, so that the recipient knows what the payment is for.
Consumers and corporates have become increasingly aware of the shortcomings of cross-border payments. Where action has been driven by regulators – be it directly or by just the threat of regulation – such as the introduction of the single euro payments area (SEPA) in Europe – service levels have been driven up and prices down. Yet in other aspects little has changed; the average fee for making a remittance has remained stubbornly close to nine per cent, despite a G8 initiative to halve it. A participant at a recent conference that the author attended described the payments industry as “some kind of forgotten, isolated island, not yet overtaken by the IT storm that has been blowing this last decade with its new concepts and business models.”
“The current models haven’t kept pace with the way business is done today,” says the IFPA’s Cousins. “They simply don’t suit modern lives and they don’t take into account the huge global population of migrant workers and the un-banked market. New electronic messaging standards have emerged that should be adopted and the full functionality that they can permit should be explored in order to address the current service issues. Banks need to accept that they need to collaborate more closely to ensure payments become more instant cross-border. There is little point in making payments faster within a country when it still takes too long to get the payment into that country.”
Mid-last century, moving value from one place to another electronically was a suitable ambition. It’s now outdated; after all nobody wants to ‘buy’ a payment, but they need payments to happen in order to satisfy some broader activity.
Payments as a business, therefore needs to redefine itself as having a much broader purpose; one built around meeting a whole host of requirements. These include transparency of service: how much will arrive, when and at what cost? The real-time communication of progress, an interactive ability to enquire into a transfer, the reconciliation of received value to account, and the incorporation of the purpose of the payment so that the beneficiary knows what the funds are being received for – all are expected and at a substantially lower cost.
Users of the service – both senders and beneficiaries – care about the outcome, but in their own terms; they don’t care, and never have, about the underlying complexities.
Cousins adds: “For the wholesale business world, my vision is for payments that support the business process; payments that are faster and have suitable processing reporting for all stakeholders. For the retail world it’s about payments that are cheaper than those today, and that meet the needs of different segments – that is from the poor or un-banked to the well-educated professional segment.
“With domestic payments many, many more transactions are processed – hundreds of times those of international payments – so domestic automated clearing houses [ACHs] have better economies of scale. It therefore makes sense to integrate those domestic ACHs internationally, by enabling them to communicate with each other directly through a single common standard. Then regulated payments service providers – banks and other authorised payments institutions -will have a different method of clearing payments internationally, with characteristics that differ from those of correspondent banking and are particularly better for low value transactions. The IPFA has established standards which enable such an approach.”
Diversity and Choice
Regulators in Europe have sought to introduce more diversity and choice, by creating a new regulatory framework for specialist payments service providers (PSPs). Hundreds of ‘alternative’ providers have also emerged, providing far greater choice. Work needs to be carried out in other jurisdictions so that such regulated providers are encouraged there; and work also needs to be done to give such organisations fair access to the national clearing and settlement systems, and to settlement accounts.
Considering the rate at which consumer expectations are changing, market forces will force change. As consumers and businesses become more savvy, they will increasingly shop around for the best foreign exchange (FX rates), as well as for the lowest fees and best service. Whether banks adapt, perhaps by collaborating more, or whether a corporate with ‘silicon valley’ mentality gets there first, remains to be seen.
The payment itself will become more commoditised. There’s plenty of evidence that consumers value timely and useful information – such as the status of the payment. Smart devices make obtaining and presenting that information possible. As the market evolves it is likely to become both bigger for providers and better for consumers.
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Europe’s opening banking regulation is finally here. After months of preparation across the continent, the Revised Payment Services Directive comes into effect on January 13.
The revised Payment Services Directive regulation, regarded as one of the most disruptive in Europe’s financial services sector, will begin to make an impact on January 13, 2018.